The Real Economy: Output, GDP, and Inflation

Encouraging developments in the industrial sector pointed to farther stabilization in major developed economies, while economic growth strengthened in Asia.

June industrial production in the U.S. shrank at its slowest pace in eight months, falling by only 0.4 percent (m/m). Retail sales rose by 0.6 percent in the same month, following a 0.5 percent increase in May. The rise in sales was largely triggered by a jump in automobile sales and higher energy prices. Housing markets continued to show signs of bottoming out.  Housing starts rose by 3.6 percent (m/m) in June, to an annual rate of 582,000. After remaining essentially unchanged from March through May, the Consumer Price Index (CPI) increased 0.7 percent (m/m) in June, reflecting a rise in energy costs.

However, not all of the U.S.’s economic data was encouraging. The budget deficit rose above the $1 trillion mark for the first time. The deficit widened by $94.3 billion in June to reach $1.1 trillion, propelled by massive government spending to combat the recession, combined with a sharp decline in tax revenues.

Industrial production started to show signs of rebounding in the euro-zone. Industrial output rose 0.5 percent (m/m) in May for the first time in nine months. Consumer prices fell modestly by 0.1 percent (y/y) in June, driven by lower energy prices. Germany’s major sentiment indicator faced a setback in June, as the ZEW index declined from 44.8 to 39.5 in June, after rising eight consecutive increases.

In the UK, consumer inflation eased to 1.8 percent in June, falling below the government’s 2 percent target for the first time in twenty months. The fall in inflation was mainly driven by falling food prices.

Asia’s economic growth strengthened in the second quarter. China’s GDP accelerated to 7.9 percent (y/y) in the second quarter, up from 6.1 percent in the first quarter. The dramatic increase in GDP is largely attributed to the $585 billion fiscal stimulus and record bank lending. Singapore’s real GDP soared an annualized 20.4 percent in the second quarter, a big improvement from the 12.7 percent contraction in the previous quarter.


Economic Policy

The U.S. Federal Reserve upgraded its projections for the remainder of 2009 as well as for 2010. According to the Fed, the U.S. economy will shrink between 1 and 1.5 percent this year, will grow more than 2 percent next year, and will experience a more rapid rebound around 4 percent in 2011. Although Fed expects the economy to remain vulnerable to shocks, it opted not to increase an already announced $1.75 trillion asset purchase program.

The European Commission proposed regulatory changes to the banking system. The proposed changes include higher capital minimums, greater disclosure requirements, and increased oversight over compensation at financial firms. The Commission hopes for the reforms to come into effect in 2011.

Mexico’s central bank lowered its key interest rate by 25 basis points to 4.5 percent. The rate cut brings the cumulative monetary policy easing to 375 basis points, the lowest level since 2005.

Financial Markets

Global equity markets rallied sharply last week, as better-than-expected second quarter company earnings reports and a rebound in the Chinese economy buoyed confidence. Major U.S. indices jumped by between 7 percent and 8 percent last week. The Dow Jones and the NASDAQ rose by 7.7 percent and 7.4 percent, respectively.

In global trading, European indices closed the week sharply higher. The UK’s FTSE 100 and German DAX gained 6.3 percent and 8.8 percent, respectively. The Japanese Nikkei 225 was up modestly by 1.2 percent.

In currency markets, the U.S. dollar was marginally weaker against the euro and British pound. The dollar ended the week 1.4 percent and 0.6 percent lower to close at $1.41 and $1.63 against the euro and the pound, respectively. The dollar gained 1.8 percent against the Japanese yen and ended the week at ¥94.2.

Major sovereign bond markets closed the week weaker, following gains in global stock markets. The yield on U.S.10-year treasury bills rose to 3.65 percent, up 35 basis points over the week. In Europe, the UK 10-year bond yield was up 7 basis points to 3.81 percent.